Explanation:
MBSs are path dependent and cannot be valued via backward induction (i.e., a binomial interest rate tree). The correct procedure is to generate thousands of individual interest rate paths via Monte Carlo analysis and then compute the OAS. The z-spread ignores optionality and is therefore inappropriate for securities with embedded options.
(Book 3, Module 44.3, LO 44.j)
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Question 85
A junior mortgage-backed securities (MBS) trader works for JW Partners. He is attempting to value an MBS and is researching the best model and spread measure for this valuation. What is the best model and spread measure for this situation?
A
Binomial tree | z-spread
B
Binomial tree | Option-adjusted spread (OAS)
C
Monte Carlo | z-spread
D
Monte Carlo | OAS
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